Cycles are a tool and should not be used to the exclusion of other tools. There is always the possibility (high probability long term) that the data will be misinterpreted or a relevant fact over looked. So use cycles to check your analysis, not as the only reason to make a decision. Interpretation is the opinion of the author and may be incorrect and should be viewed in that light.

Monday, March 21, 2011

watching the VIX

Many watch for extreme moves in the VIX to try an pinpoint tops and bottoms. IMO it is not that simple. They use envelopes:

The concept is extreme moves in the VIX can help in spotting tops or bottoms. Not that complex a concept. But you don't need envelopes or Bollinger bands to spot extremes. Any teacher knows about the Bell Curve and how in a normal distribution 2 standard deviations covers either side of the midpoint about 47.5% of the population (or 95% on both sides of the midpoint). This is how teachers grade on a curve (figures break points for a grade). See for yourself:

So we apply the Bell Curve as a teacher would to a grade (sort of). Say the VIX is at 15 (a bottom). 95% of 15 is 14.25 - so a move to 29.25 (15 + 14.25) would be an extreme move up. If the VIX were at 30 (a top) we would use 47.5% of 30 (14.25 points). A move down from 30 to 15.75 would be an extreme move off the top....

We have just encountered such an extreme move (03/16). See for yourself:

Now the VIX normally moves inverse to the market (it goes up when the market goes down and it goes down when the market goes up). So an extreme move up suggests an extreme move down in the market (So we are now on alert for a bottom).

But this alone is not enough to call it a bottom. We need confirmation of some sort. I Suggest the best confirmation is market action. Research suggests to me we need 3-4 consecutive up days to confirm we bottomed and a trend reversal is taking place.

We use mirror image logic for a trend reversal down. NOTE - this methodology will not call all reversals, so you will use it in conjunction with other tools, but it is reliable when it does give a signal.

UPDATE 03-21 04:30pm EDT - we got 3 consecutive up days to confirm our VIX signal. That means the trend should now be up.

I have several posts about cycles, cycle lengths, how to isolate cycles, etc. So that is probably a good place to start.

You will find a couple of guys online (articles) that may be worth reading: Clif Droke (Google Clif Droke cycles) and David Knox Baker (Google it).

Finally there are a plethora of books on cycles. The first one i ever read was by JM Hurst: http://www.forexmt4.com/_MT4_Systems%20Documentation/J.M.%20Hurst%20-%20The%20Profit%20Magic%20of%20Stock%20Transaction%20Timing.pdf

I have started to go thru everything on you blog. I ordered the Clif Droke book on cycles. I also found an interesting site, http://www.foundationforthestudyofcycles.org/ . I'm sure all this will keep me occupied for some time.

Cycle Dawg

Followers

Old as dirt

I have long been a proponent of TA. I have looked at a lot of different methods. In the 70s I maintained about 50 P&F charts manually (pre Web). Some TA approaches work better than others.
In the end I decided that cycles were as good as any, much simplier than most to use and required less time to do.
You may have your own TA and I encourage you to use it and only use my post/opinions as a check on your TA.